2.1 Conventional banking systems
Conventional banking does not follow a stipulated pattern while conducting its business. In countries with an Anglo-Saxon background such as England, the commercial banking pattern dominates while Germany, France, and Japan peg their services on the universal banking rule. Commercial banking bases its patterns on pure financial intermediation models. This is where the banks normally borrow from those who have saved with them and then lend the borrowed funds to entrepreneurs or enterprises. The difference in the rates between the borrowing and the lending of these funds creates their profit margin. Thee banks are also seen to provide services such as letters of credit and guarantees amongst the avenues for making more money (El Qorchi, 2005). A portion of what they get in terms of their profits will also feature the low-cost funds that they get to obtain from the demand deposits within their line of banking. The commercial banks, in reality, are prohibited from trading and the shareholding capacity gets restricted to small portions of the institution’s net worth.
The reserve system allows them to produce derivative deposits where they get to multiply and increase even the low-cost funds and resources they have. Nonetheless, this process of lending may present the bank with a problem. The borrowers have more information about their operations when comparing them to the lenders. While the banks act as lenders, they are disadvantaged in this area because of the information asymmetry given that the borrowers may choose to hold back the information from the banks (Diamond and Rajan, 2001). The borrower, therefore, may use the loan for different purposes other than those specified while requesting for it. This exposes the bank to risks. The borrower may also misrepresent the cash flows with the intent of defrauding the bank or even declare bankruptcy to avoid repaying the loan. One can say that the ability of getting the loan repaid will depend solely on the utilization of the funds for the stated purposes. They must monitor the use of the funds within the agreed platform with the borrower. Thus, before being accorded any loan, the borrower’s credit rating is essential (Demirgüç-Kunt, Laeven and Levine, 2004).

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